Premiers could be reaching for their wallets

Rather than defending deep corporate tax cuts, the Conservative party is emphasizing promised personal tax breaks: income splitting for some households, doubled Tax-Free Savings Accounts (TFSAs), and tax credits for more athletic and artistic pursuits.

Journalists and opposition politicians quickly pointed out that these promises are delayed until the federal budget is balanced, which is not projected until after the next election. Less noticed is the fact that provincial governments would bear a significant portion of the cost of these postdated tax changes.

Provincial income tax generally applies to income as defined by federal tax rules. Shifting income to a spouse in a lower tax bracket or into a TFSA reduces both federal and provincial revenues.

It would be constitutionally possible, but practically difficult, for provinces to disallow income splitting for provincial tax purposes or to tax investment gains realized inside TFSAs. Provincial governments would not be obliged to create provincial credits for fitness and arts spending eligible for the promised federal credits. However, provinces set a precedent of doing so with the children’s fitness credit.

Would these contractions of the shared tax base be delayed until provincial budgets are balanced? The largest provinces face greater fiscal challenges than Ottawa. Surely Canadians should be as mindful of provincial deficits, which are financed at higher interest rates than federal borrowing.

The Conservative platform estimates that income splitting and the fitness/arts credits will reduce annual federal revenue by $2.5 billion and $500 million respectively. It estimates that doubling TFSAs will cost very little in the immediate term.

But as TFSA contributions accumulate and returns compound, the fiscal cost of not taxing them grows exponentially. Budget 2008 projected that the current $5,000 threshold will ultimately reduce annual federal revenues by $3 billion.

The additional cost of doubling the threshold would be below $3 billion because fewer people could afford to contribute $10,000. However, the three Conservative promises could easily punch a $5-billion hole in the federal budget.

How much would they cost the provinces? Provincial income tax generates about two-thirds as much revenue as federal income tax.

Top marginal rates are especially important for income splitting and TFSAs, which disproportionately benefit high-income Canadians. Outside of Quebec, top provincial tax rates are about half of the top federal rate.

The upshot is that federal Conservative promises could easily reduce combined provincial tax revenues by between $2 billion and $3 billion per year.

Furthermore, federal transfers to the provinces are up for renegotiation in 2014. After musing about austerity, the federal Conservatives have pledged to continue the current Canada health transfer escalator.

However, they have already capped total equalization payments. The implication is that Ontario’s equalization entitlement can expand only by squeezing other recipient provinces.

The Conservatives have made no commitments regarding the Canada social transfer or territorial formula financing. Given reduced federal tax revenue, Canadians have reason to fear a clampdown on such transfers.

Taken together, the Canada social transfer, equalization and territorial formula financing are larger than the Canada health transfer. Since all are block grants, promising to increase the one labeled “health” is of little consequence. What matters is the overall level of federal support for provincial and territorial governments, which deliver health-care services.

Arcane issues like fiscal federalism rarely ride high on the election campaign trail.

However, promises that would shrink the provincial income tax base and mixed messages about federal-provincial transfers should cause voters to ask how much another Conservative government in Ottawa would cost their province.

Erin Weir is a Canadian expatriate working as senior economist for the International Trade Union Confederation in Brussels.

This entry was posted on Monday, April 25th, 2011 at 12:09 pm and is filed under Governance Policy Context. You can follow any responses to this entry through the RSS 2.0 feed.
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